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Stress Testing Equity Portfolio Time to Liquidate

Article Quant Q&A · Author: tweedi
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Summary

The document describes a liquidity-risk measure for a long-only equity portfolio: estimate how many days it would take to sell each holding. Under ordinary conditions, the measure can use average daily volume and an assumed participation rate. To represent stressed conditions, the answer proposes using historically low trading volumes, such as the 95th- or 99th-worst observations, and applying conservative participation-rate assumptions.

Rather than prescribing one stress participation rate, it suggests comparing scenarios at different rates, with examples of 5%, 10%, and 15%. The resulting liquidation times show how sensitive the portfolio is to assumptions about market access. It also suggests scaling daily VaR by the square root of liquidation time to estimate losses over the exit horizon. This is a simplified risk approach: it focuses on the ability to convert holdings to cash, while treating transaction cost as secondary, and does not address price impact, correlated selling, or whether square-root-of-time VaR assumptions hold during a fire sale.

Key ideas

  • Estimate liquidation time from position size, trading volume, and participation rate.
  • Stress volume using historically weak trading days.
  • Compare multiple participation-rate scenarios instead of relying on one assumption.
  • The answer proposes scaling daily VaR by the square root of liquidation time.
  • The method does not model price impact or validate VaR assumptions under fire-sale conditions.

Tags

EquitiesRisk managementExecutionMarket microstructure
Full text
# Stressing liquidity (time to liquidate) of a long only equity fund using participation rate or bid ask


# Stressing liquidity (time to liquidate) of a long only equity fund using participation rate or bid ask












My company is looking to launch a new long only global equity fund. The product committee wishes to see a risk analysis covering various risks, including liquidity. The main measure is time to liquidate (i.e. how long will it take to sell this portfolio).

For normal market conditions it is straightforward: I look at average volume for each ISIN, assume a participation rate somewhere between 10% and 20% and I get my metric.

However how do you stress this metric to get a time to liquidate in fire sales conditions? Should I assume that the participation rate will be significantly lower? if yes by how much and why?

## Answer by AK88 (score 2)

https://quant.stackexchange.com/a/49493

If you are concerned about how fast can you convert your equity holdings into cash, then you would care about the ADV (average daily volume) and cost would be a secondary issue.

What you can do is to look at historical ADV and pick the 95th or 99th worst volume, assume a conservative participation rate and see how long does it take you to liquidate a position. You can also choose different scenarios for the participation rate (e.g. 5%, 10%, 15%) and see how these vary.

After figuring the number of days to liquidate your position, you can use this information to scale up your daily VaR measure. Since VaR shows you the potential amount of loss at certain confidence level, scaling it up by the square root of time will show how much loss you are going to incur.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.